Hedge-fund managers ponder Armageddon

Covepoint’s Sankaran sees China creating common Asian currency

By

AlistairBarr

LAS VEGAS (MarketWatch) — A collapse of the banking system, the demise of the U.S. dollar as the reserve currency, another oil shock, a new round of junk-bond defaults and a meltdown in Japan’s bond market were among the doomsday scenarios explored by hedge-fund managers at a conference in Las Vegas Thursday.

Since the 2008 financial crisis, many hedge funds have added trades that could protect against losses from big, unexpected events — now known as black swans, a term coined by investor Nassim Taleb.

Sinnott expects another oil shock, like the one that plunged the U.S. economy into recession during the 1970s. During that period, energy costs went from 8% of U.S. gross domestic product to about 15%, “and our economy crashed,” he added. “That’s likely to happen again.”

Kayne is a major investor in the energy industry; its private-equity business owns roughly 40 companies in the sector that are mainly focused on drilling.

One way to handle black-swan events, according to Sinnott, is to own companies, or large stakes in companies, and actively improve them — something he called “thrust” investing.

“In our hedge funds, we don’t have an investment where we don’t personally know the CEO,” he said, noting that the firm has about 70 of such positions.

‘Unrepentant bear’

Eric Sprott of Sprott Asset Management called himself an “unrepentant bear” during the conference.

“We’ve been in a secular bear market since 2000,” he said. “Governments and central banks have tried to prevent the natural flow of that, which has led to housing mania, bank bailouts and financial crisis.”

Banks remain too leveraged at roughly 20 to 1 and their assets are still mainly government bonds and mortgages, argued Sprott, while noting that government bonds may be overvalued and the housing market keeps going down.

Sprott has been a bullish on gold for more than a decade. He recently started a silver fund, and said Thursday that precious metals are “the way to survive the coming Armageddon.”

Silver slumped in recent weeks, and Sprott said the price of the metal has been “manipulated down.”

Silver fell by $6 in 13 minutes late on a recent Sunday, when the market was thinnest, he commented. That was followed by four margin increases, Sprott elaborated.

Asian common currency

China may create a common currency in Asia, part of a shift away from the U.S. dollar as the world’s reserve currency, Karthik Sankaran of currency-trading hedge fund firm Covepoint Capital Advisors said at the conference.

“The rest of the world is getting increasingly concerned about the willingness of the U.S. to maintain the dollar as a reserve currency and a store of value,” he remarked.

So there are efforts under way to create different payment systems, as Europe did with the euro, according to the Covepoint manager. “We’re starting to get to the point where the Chinese want to do something like this in Asia,” he said.

Saudi Arabia could also depeg its currency from the U.S. dollar and crude oil may become denominated in a new currency, Sankaran added.

New defaults

“We’re making new product that’s going to default. We’re gonna make more,” he said, while predicting that returns in the high-yield market may be lackluster over the next three to five years. “Right now it looks good, because default rates are low.”

However, some companies have been borrowing so much that their market capitalization is lower than the amount of debt they have outstanding, according to the GoldenTree manager.

Bass-ing Japan

Kyle Bass, head of Hayman Capital, said he’s adding to bets against Japanese government bonds.

Bass has been betting that interest rates on these bonds will spike as the country is forced to borrow more from overseas investors, rather than from domestic savers.

Such savers have helped Japan finance huge budget deficits for years. But its population is getting older now and will start spending rather than saving more, Bass argues.

“They will sell more adult diapers than kids’ diapers by 2015,” he said.

Fannie and Freddie bet

Despite being bearish on Japan, Bass indicated that his main hedge fund is about 85% long.

The manager said he’s betting on the preferred stock of government-owned mortgage giants Fannie Mae
FNMA, +0.36%
and Freddie Mac
FMCC, -0.37%
He stressed that he’s not interested in the equity of the companies.

The securities “could be an eight- to 10-bagger from here,” he commented during the conference.

Bass has been a critic of Fannie and Freddie and reckons they should ultimately be shut down. However, on Thursday he said the companies are currently making money before interest payments on 10% debt they owe the U.S. government.

Big tax-related assets could be brought back onto their balance sheets, and the fee they charge for guaranteeing mortgages should be increased from 20 basis points to 60 basis points over several years, he added.

This means the preferred shares are potentially worth a lot more, Bass explained. “The preferreds still trade at 8 cents on the dollar; it’s crazy.”

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